Portfolio manager outlines key investment themes for its leading technology ETF and explains how the pandemic has changed the landscape
Technology is the talk of the town again after recent volatility. The spike in bond yields saw many speculative equity stocks – many in the tech space – take a hit, erasing chunks of this year’s gains. On the flip side, many bought the dip and money continues to be pumped into technology as it shapes our future, both personally and professionally.
It’s a trend the team behind the Brompton Tech Leaders Income ETF, which is approaching its 10th anniversary, understands deeply. It’s the top performing active ETF in Canada over the past five years, with a five-year annual total return of 25.7% and a yearly performance of 49.4%, reflecting the tech sector surge.
Mike Clare, VP and portfolio and manager, said: “This transformation [in technology] was accelerated probably five or 10 years into the future with the COVID-19 pandemic as businesses, individuals and governments adopted technology solutions to work from home or offer solutions remotely to customers. It’s really driving strong fundamentals for the technology space.”
He added that as well as strong secular growth, he sees both cyclical and defensive characteristics. Tech companies today are much different than they were 20-25 years ago during the ’90s’ tech bubble, characterized in 2021 by high profitability, free cash flow generation, high margins, strong balance sheets, often with cash positions, and recurring revenue models.
“Then you've got the cyclical aspect, too, through semiconductors and other parts of the sector,” he said. “When all is said and done, it adds up to a continued outperformance of the tech sector versus the broad market over the next decade or so.”
To examine why the long-term looks bright for tech, Clare highlighted some key investment themes he and his team delve into when constructing the portfolio, some of which are at an earlier stages of development than others.
While the cloud has been one of the biggest trends of the past decade, accelerated by COVID and remote working, Clare believes it’s only just getting started. From iCloud and Google Drive to Zoom and cloud-based services with Microsoft, it’s changed how companies work.
Then there are business models that have been built around the cloud like Salesforce and ServiceNow or Uber and AirBnB, while others have been able to demonstrate extremely rapid growth that wouldn't be possible if they had to build using their own servers, like Slack, for example.
“Despite the high growth we've seen recently, we think we're just getting started,” Clare said. “Piper Sandler data expects that we’ll see an 18% annual growth rate over the next decade with the cloud opportunity ultimately reaching more than a trillion dollars in revenue by 2030.
“The reason that's possible is because cloud is still a small percentage of overall I.T. spending, about 6% globally. There is runway here for growth opportunities.”
These connections are expanding … rapidly. Clare pointed to a Cisco projection that about 27 billion devices will be connected to a network this year, driven by smartphones, tablets, computers, and the Internet of Things, whether that’s connected thermostats or TVs, for example.
We are also at an early stage of the 5G rollout and the portfolio manager believes there'll be new business models that are centered solely around 5G.
He explained: “It’s important to keep in mind that 5G isn't just higher network speeds, but it's also lower latency. That means a shorter time delay between transmitting information, which is going to allow us to see more real-time applications like potentially remote surgery or connected cars, which goes hand in hand with the adoption of self-driving vehicles.
“What we’re also seeing in this space is an emerging theme around low Earth orbiting satellites, which we think will begin to augment 5G coverage with service to remote and rural areas; that’s an area to watch as well.”
Cash transactions continue to decline. While in Canada they still account for about 19% of total payment volume, Sweden has gone largely cashless. Many businesses still primarily use old technology like checks and wires to do transactions, so companies like MasterCard and others that are working on real-time payment rails for businesses have a huge opportunity.
Clare said: “One of the biggest roadblocks to increase adoption of digital payments has been security but now digital wallets are helping to solve that through biometric solutions like putting your fingerprint on your phone or using facial recognition technology in order to trigger that payment.
“The most recent innovative technology we see in the space is blockchain, also known as distributed ledger technology. The media does tend to focus on Bitcoin but we think it's the technology behind Bitcoin that's the most promising because it removes the need for a central clearing house, speeds up verification and settlement times and has the potential to unlock quite a bit of savings within the global financial system.”
Brompton also believes AI is at an inflection point here, getting closer to mimicking the human brain. Critically, it’s “more than science fiction and robots taking over the world” and is becoming more mainstream, unleashing the potential to drive workforce automation across both manufacturing and knowledge-based workers.
“We think that, ultimately, AI will be used in conjunction with human workers to help solve problems,” Clare said. “It’s not necessarily a replacement for human workers, who will be able to use artificial intelligence to become much more productive at what they do. This drives efficiencies and leads to more effective decision-making.
“PwC actually estimates that this has the potential to transform our economy and GDP potential over the next decade or so by possibly adding $15 trillion to global GDP. So, this is massive opportunity for our investment portfolio.”
The fabric that makes all the above possible comes in the form of semiconductors, and the chips are becoming smaller and more powerful, while memory requirements to store and retrieve data generated by our digital economy are growing exponentially.
There has been robust demand for semiconductor chips from data centers, which power the cloud consumer devices, and shortages are now starting to arise.
Clare said: “As we go through a period of strong economic growth here, semiconductors are a good cyclical part of the tech sector we can play, where these shortages will help drive pricing power and also the potential for growth as the big semi companies bring more capacity online to meet this demand.”